LOSING CONTROL (29 page)

What happens if the property rights surrounding investments by the developed world in the emerging nations prove to be inadequate?
Investors in the developed world are expecting more youthful populations in the emerging world to work hard for them in their retirement: is this really an economic match made in heaven?
And, in the attempt to secure food and fuel supplies, will nations find themselves fighting each other for access to scarce resources?
That, after all, was one of the sources of conflict between Japan and the West in the Second World War.
Japan’s decision to attack Pearl Harbor in 1941 was partly prompted by its military government’s response to the embargo placed on Japan by the Americans, British, Dutch (in exile) and Australians.
The aim of the embargo was, of
course, to curb Japan’s aggression, particularly in China, by starving it of much-needed steel and fuel.
Instead, Japan’s rulers became even more aggressive, believing that a successful conclusion of its war with China could only be reached by a Japanese move into Malaya and the Dutch East Indies alongside a pre-emptive attack on the US fleet to prevent the US from siding with the UK in the event of a Japanese pre-emptive strike.

The history of the world is full of strategic miscalculations.
There’s no reason to believe the future will be any different.
The West can play its part in ensuring the smooth progression of globalization, but it can also throw the whole process into reverse.

For many people, the collapse of Soviet-style communism and the reform of Chinese communism signalled the triumph of free market thinking.
An economic and political nirvana beckoned.
Liberal markets were the secret behind the West’s economic success over the last few hundred years.
It seemed to follow that, with the spread of market capitalism far and wide, other nations and their people could look forward to a future of Western-style economic progress.
The West, meanwhile, would continue to advance, making profits from its investments in the emerging world while delivering continued productivity advances inspired by the enlightened values of liberal democracy: freedom of speech and freedom of association.

These arguments, however, are unsound.
Western progress did not depend solely on free market capitalism.
Nation states, and the empires they created, frequently intervened to protect ‘commercial’ interests.
Sometimes, these interventions were supportive of free
markets.
An effective legal system, after all, is a necessary condition of free market success: without property rights, there is no incentive to save, borrow or invest.
At other times, however, these interventions were deliberately designed to uphold one nation’s interests against another’s.
Ironically, market forces appeared to work well within the Western world, in part because they were not allowed to work elsewhere.
In the nineteenth century, Western nations rigged market rules to suit themselves, whether through acts of protectionism, drug trafficking or the law of the gunboat.
Through much of the twentieth century, experiments with Marxist-Leninism kept many nations in the economic deep-freeze, even as the developed nations flourished.

Market-led solutions are profoundly amoral and, thus, fail to address many of the key issues of political economy.
Market forces may lead to more efficient outcomes, but efficiency says nothing about whether the rewards are fairly distributed.
For markets to provide widespread benefits, property rights and the rule of law are most certainly required, but they may not be enough.
As Adam Smith wrote in
The Wealth of Nations
, ‘Wherever there is great property, there is great inequality .
.
.
the affluence of the rich excites the indignation of the poor, who are often driven by want, and prompted by envy, to invade his possessions .
.
.
The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government.’
This view can be taken in one of two ways, depending on which side of the political spectrum you sit.
Either the rich need the protection of civil government or the government has to intervene to calm the poor through an official ‘invasion’ – by redistributive taxation – of the possessions of the rich.
¹

As markets open up all over the world, so the West’s ability to rig those markets to suit its own interests is on the wane.
As a result, for many in the West, the market’s amorality threatens to become a significant problem, increasingly reshaping attitudes towards
globalization.
The world economy is growing quickly and, as a result, many millions of people are being pulled out of poverty.
The gap between rich and poor (but not very poor) nations is narrowing.
Yet the gap between rich and poor within nations is widening.
In relative terms, at least, globalization appears to be creating a world of winners and losers.
The unleashing of market forces around the world and the contemporaneous, if paradoxical, rise of state capitalism have had surprising effects which, in my view, policymakers in the developed world have not fully understood.

The barometers by which policymakers assess economic weather conditions have started to give false readings.
Trade flows between the developed and emerging worlds have flourished, but this isn’t purely the Ricardian trade of comparative advantage.
Japan’s experience suggests that outsourcing and off-shoring can lead to domestic economic stagnation.
Pretending that Japan is ‘different’ and therefore carries no immediate relevance for the US or the UK may be comforting but probably isn’t right.
Capital can cross borders more easily.
In the process, the economic rents earned by some Western workers – in the form of high wages, healthcare benefits, lucrative pensions and employment rights – are under threat.

Long-term interest rates – the rates that matter for savers and for businesses – have fallen victim to the savings behaviour of emerging nations, most obviously China.
As a result, it’s become increasingly difficult for investors to work out the ‘right’ price for all sorts of assets, ranging from equities to housing and from commodities to asset-backed securities.
As uncertainty has increased, the volatility of asset prices has risen sharply.
After many decades in which the easy answer to pension saving was ‘buy equities’, there are no longer any hard-and-fast rules.
In fact, the only hard rule now is that most Western savers will not be able to accumulate sufficient assets to allow a comfortable retirement.
The rise of state capitalism provides a threat to cross-border property rights for ageing Western populations.
Meanwhile, the growing emerging-nation demand for raw materials will reduce the real value of Western wealth because of higher energy and food prices.

There is no pot of gold at the end of the rainbow of investment opportunities.
As the emerging economies expand, so their own claims on global resources will rise.
In the absence of a productivity boost in the world economy the likes of which have never before been seen, this will inevitably lead to a redistribution of global income and wealth.
There are investment opportunities in the emerging world, but it’s also important to learn the lessons of the gold rush: everyone can dream of being rich, but a lot of people may become poor in the pursuit of their dreams.

If inflation is low and stable, economic weather conditions are supposed to be set fair.
This conclusion, however, is no longer safe.
Low inflation may be more a result of good luck than of good judgement, a reflection of external forces beyond the control or influence of a central bank.
Emerging economies have become the key players in commodity markets while their own monetary decisions increasingly have an impact on financial conditions in the developed world.

Policymakers, however, are human: they like to take the credit for economic success, even where no credit is due.
And, in doing so, they keep interest rates either too low or too high, accepting near-term success on inflation at the cost of longer-term economic instability.
Put another way, the achievement of price stability may inadvertently lead to the creation of deeper economic imbalances of the kind which contributed to the 2007/8 credit crunch.

Our economic barometers tell us more today about income distribution than they do about macroeconomic stability.
Domestic explanations for the growing gap between haves and have-nots work up to a point, but the most compelling reason for widening income inequality is the arrival on the world stage of the emerging nations.
There are plenty of benefits from globalization, but
those benefits are either going to the many in the emerging world or the very few in the developed world.
A big chunk of the developed world’s population has derived little direct benefit from globalization.

The rise of state capitalism can be understood more easily given this background of rising income inequality.
Nation states will increasingly be interested in subverting market mechanisms to ensure domestic social stability.
There’s nothing new about this process: from the East India Company to Halliburton, the West has successfully played this game for centuries.
The difference this time around, however, is that China and Russia, in particular, can also play this big boys’ game.
Indeed, the growing links between emerging nations suggest the rise of new alliances that will ultimately threaten Western interests.
Imagine, for example, that emerging nations are increasingly able to rig food and energy markets to suit their own purposes.

Meanwhile, the global financial system is increasingly unstable on a systemic basis, a reflection of moves towards a single capital market, multiple (and multiplying) nation states and, at the heart of the issue, a US dollar that can no longer easily serve the interests of the world economy very well.
It is possible to piece together policies that would allow a smooth evolution away from a dollar-based financial system – notably through the creation of major currency ‘blocs’ in which individual nations would all enjoy monetary voting rights – but what is possible isn’t always probable.
The alternative, from a Chinese point of view, is to bolster the renminbi’s reserve currency status.
This will be many years in the making.
Meanwhile, the dollar’s demise as a reserve currency will inject greater volatility into the world’s financial system and, for US citizens, will doubtless hugely raise the cost of imports, making US consumers worse off.
It’s another way of saying that, for too long, the US has been living beyond its means.

Globalization is not one-way traffic.
Over the centuries, there have been many reversals and many shifts in economic and political tectonic plates.
At least some of those reversals have come about because of the political rejection of the forces of globalization.
Markets work because nations allow them to: nations can just as easily stop them working if they wish to.
The big mistake in this latest wave of globalization has been the developed world’s collective failure to think about globalization’s evolution from the perspective of both winners and losers.
Pretending that everyone is automatically a winner both raises expectations and sows the seeds of future disenchantment.

A few years ago, I asked a German friend how his nation had coped with the economic backlash that followed reunification.
West Germany, after all, had been an economic powerhouse in the 1970s and 1980s, yet its performance had withered in the mid-1990s.
Growth had ebbed away, taxes had gone up, property prices had fallen and unemployment had risen.

The answer was simple.
West Germans knew that the integration of the East would be economically expensive.
They knew there would be severe adjustment costs.
They knew sacrifices would have to be made.
They also knew, however, that the sacrifices were worth it.
The German people had been separated by a physical and economic wall for too long.

The developed world as a whole, however, doesn’t feel the collective warmth towards the emerging world that West Germans felt for East Germans.
Globalization delivers tremendous benefits, but for the developed world comes with a big bill attached.
The risk is that, in time, the developed world refuses to pay up.
At that point, globalization disintegrates, whether through protectionism, financial
collapse, ethnic and religious rivalry or war.
The developed world needs to decide whether it wants the emerging nations to enjoy the economic opportunities that, for so long, had been enjoyed only by the privileged Western few, or, instead, whether it wants to retreat into a bunker that will only leave the world as a whole facing political and economic catastrophe.

If the developed world goes down the first path, it will have to accept a smaller role in world affairs.
The emergence of the G20 marks only the beginning of a major shift in global economic and political power.
Western workers may still benefit from income gains, but those gains will be smaller than in the past.
Pensioners will find life increasingly difficult: a mixture of low interest rates and high commodity prices will reduce both their incomes and their spending power.
Ageing Western populations will be forced to sell assets – increasingly to new owners in the emerging nations – and, in the process, will lose control of the ‘commanding heights’ of the global economy.
Our children will have to compete with graduates from the emerging world for the best jobs.
They will also have to pay the taxes to repay the huge debts of the current generation.
Lower US growth will shrink military muscle, reducing the global reach of today’s most powerful military machine.
Governments will have to think far more seriously about income and wealth redistribution.
Otherwise, they will find that popular support for globalization begins to wane.

This might sound bleak.
The alternative, however, is far worse.
Severing the links altogether between the developed and emerging worlds would make life much more difficult: no cheap access to Chinese savings, a collapse in the dollar, a drying-up of world trade, a meltdown in global capital markets, a string of government debt defaults, a massive increase in unemployment and the possibility of war.
The world economy has flourished since the Second World War and, in particular, since the end of the Cold War.
To throw openness
away in an attempt to defend Western interests might be a vote-winner, but it would ultimately be a job-loser: the Depression tells you all you need to know about what happens when economies disengage from one another.
It is surely better for the West to lose relatively than it is for the world as a whole to lose absolutely.
As its population ages, I hope the West gains the wisdom to make the right choice.